Opinion
MEMORANDUM DECISION
LAURA S. TAYLOR, Bankruptcy Judge.
Debtor Robert Alan Weilhammer ("Debtor") inherited his mother's individual retirement account (the "Initial IRA") on her death and directly transferred the funds held therein to an individual retirement account established in his name as beneficiary (the "Recipient IRA"). Thereafter, Debtor and his wife filed a chapter 7 case and claimed an exemption in the Recipient IRA. The chapter 7 trustee objects to this claim of exemption. Thus, this Court now must determine whether Debtor appropriately claims an exemption in the Recipient IRA under 11 U.S.C. § 522(b)(3)(C) .
Hereinafter: references to code sections refer to Title 11 of the United States Code, also referred to as the "Bankruptcy Code" and references to "IRC sections" refer to Title 26 of the United States Code, also referred to as the "Internal Revenue Code", unless otherwise specified. References to rules refer to the Federal Rules of Bankruptcy Procedure, unless otherwise specified.
STATEMENT OF THE FACTS
During her lifetime, the Debtor's mother, Mary Weilhammer, established and funded the Initial IRA. While the evidence underlying this dispute is thin, there is no dispute that the Initial IRA was a properly established retirement account that was exempt from taxation under IRC section 408.
The Initial IRA named Debtor as the beneficiary properly entitled to inherit the Initial IRA upon his mother's death.
Ms. Weilhammer died prior to October 5, 2009, the petition date in this case (the "Petition Date"). Debtor then inherited the Initial IRA. Again, the chapter 7 trustee ("Trustee") does not dispute that Debtor properly preserved the tax-exempt character of the funds held therein. In particular, through a trustee-to-trustee transfer authorized by IRC section 402, Debtor transferred the funds in the tax-exempt Initial IRA to the tax-exempt Recipient IRA. Trustee acknowledges indirectly through her argument that Debtor did not contribute any of his own funds to the Recipient IRA.
After creation of the Recipient IRA and prior to the Petition Date, the Debtor withdrew approximately $55, 182.12 from the Recipient IRA. These distributions were taxable to the Debtor, but the funds remaining in the Recipient IRA remained tax exempt as of the Petition Date.
Debtor and his wife, Adele Villalobos Weilhammer, filed their joint chapter 7 case on the Petition Date. On schedule C, Debtor and his wife selected 11 U.S.C. § 522(b)(3) as the exemptions to which they are entitled, listed the Recipient IRA as an exempt asset, and specified Cal. Code Civ. Proc. § 703.140(b)(10)(E) as the "Law Providing [ ] Exemption." The Trustee filed a timely objection to this claim of exemption, and the Debtor responded and set this matter for hearing. In this response, the Debtor argued, among other things, that the Recipient IRA also is exempt under subsection (C) of section 522(b)(3).
The form "Schedule C - Property Claimed As Exempt" requires that debtors select the appropriate Bankruptcy Code exemption section to which they are entitled by checking a box- either 11 U.S.C. § 522(b)(2) (the federal exemptions) or 11 U.S.C. § 522(b)(3) (the state exemptions).
The Trustee also objected to the Debtor's claim of exemption in a second IRA, but that matter was resolved by the parties, and a decision by this Court is not required.
The Court held an initial hearing on this matter on April 22, 2010 and requested further briefing. The Court received additional documents and held final oral argument on June 16, 2010. This matter is now ready for decision.
DISCUSSION
A. The Court Must Construe Exemptions Liberally In Favor Of The Debtor, And The Trustee Bears The Burden Of Proof Here.
Section 522(b) allows a chapter 7 debtor to exempt certain property otherwise includable in his bankruptcy estate. Properly exempted property is not available to pay the claims of the debtor's creditors. The Court must construe the claim of exemption in the Recipient IRA liberally in favor of the Debtor. See, Arrol v. Broach (In re Arrol), 170 F.3d 934, 937 (9th Cir. 1999). And the Trustee, as the party objecting to a claim of exemption, bears the burden of proving that the Debtor improperly claims this exemption. Kelley v. Locke (In re Kelley), 300 B.R. 11, 14 (9th Cir. BAP 2003) [citing In re Carter, 182 F.3d 1027, 1029 (9th Cir. 1999)]. The critical date for determining exemptions is the petition date. Goswami v. MTC Distributing (In re Goswami), 304 B.R. 386, 391-92 (9th Cir. BAP 2003).
B. As A Result Of BAPCPA, The Debtor Is Entitled To An Exemption Under Section 522(b)(3)(C).
The Bankruptcy Code allows for exemptions under either or both of state or federal law. It further permits each state to preclude the use of the federal exemptions set forth in section 522(d) and to require that a debtor utilize exemptions as provided for by state law. 11 U.S.C. § 522(b)(2). Pursuant to this authority, California elected state exemptions for its citizens. Cal. Code Civ. Proc. § 703.130(a).
In 2005, Congress enacted the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA"). BAPCPA provides an additional retirement fund exemption for individuals in states that opt out of the federal exemption scheme. A California debtor, thus, still may use the California retirement fund exemption, but the California debtor also has a right to the specific federal exemption listed in section 522(b)(3)(C), which provides an exemption for: "retirement funds to the extent that those funds are in a fund or account that is exempt from taxation under section 401, 403, 408, 408A, 414, 457, or 501(a) of the Internal Revenue Code of 1986." 11 U.S.C. § 522(b)(3)(C); and see H. Rep. No. 109-31(1), 109th Cong., 1st Sess. 63-64 (2005), reprinted in 2005 WL 832198, 2005 U.S.C.C.A.N. 88 (the BAPCPA amendment to section 522 "ensures that the specified retirement funds are exempt under state as well as Federal law.").
The language of section 522(b)(3)(C) is identical to the language of section 522(d)(12), the statute containing the federal retirement fund exemption. Section 522(b)(3)(C), thus, protects debtors residing in states that opt out of the federal exemption scheme, as it creates a uniform minimum for exemptions for retirement funds in all bankruptcy cases notwithstanding the provisions and limitations of state law.
In schedule C, the Debtor specified the statutory section under California state law for his exemption of the Recipient IRA. After receipt of the Trustee's objection, however, the Debtor also argued, in the alternative, that he is entitled to the exemption under section 522(b)(3)(C). As Debtor selected exemptions under section 522(b)(3) this is sufficient, but in any event, the Trustee did not object to this Court's consideration of issues arising under section 522(b)(3)(C) and, instead, directly addressed this issue in papers filed with the Court.
C. Is An Inherited IRA Entitled To The Section 522(b)(3)(C) Exemption?
In the present case, the Initial IRA was an "individual retirement account" within the meaning of IRC section 408(a). The parties appear to agree that the Recipient IRA is an "inherited individual retirement account" within the meaning of IRC section 408(d)(3)(C). Recently, several courts have wrestled with the applicability of the sections 522(d)(12) and 522(b)(3)(C) exemptions to inherited IRAs. A review of this case law provides a path for decision in this case.
The Court will use the term "inherited IRA" to refer to an IRA fitting the definition of IRC section 408(d)(3)(C) hereafter.
1. In re Nessa. The Bankruptcy Appellate Panel for the Eighth Circuit recently considered this issue. Doeling v. Nessa (In re Nessa), 426 B.R. 312 (8th Cir. BAP 2010). In Nessa, the debtor made a trustee-to-trustee transfer of the funds in an IRA she had inherited from her father prior to initiating a chapter 7 case. Id. at 313. The Nessa court emphasized that Ms. Nessa complied fully with the rules required to maintain the tax exempt character of an inherited IRA; she did not withdraw any funds prior to rollover to a newly created IRA, and she did not make contributions of her funds to the IRA. Id. at 313; see also 26 U.S.C. § 408(d)(3)(C). The Nessa court then found that the debtor properly claimed her inherited IRA as exempt under section 522(d)(12). It noted that a section 522(d)(12) exemption must meet only two requirements: "(1) the amount the debtor seeks to exempt must be retirement funds; and (2) the retirement funds must be in an account that is exempt from taxation under one of the provisions of the Internal Revenue Code set forth [in section 522(d)(12)]." Id. at 314. It then concluded that the debtor's inherited IRA satisfied both requirements.
First, the Nessa court found that the funds at issue were retirement funds, albeit those of Ms. Nessa's father. The Nessa court rejected the argument that retirement funds for purposes of section 522(d)(12) must be created from a debtor's own efforts and assets and pointed out that the statute makes no such distinction and that to so define retirement funds would: "... impermissibly limit the statute beyond its plain language." Id. at 314 [citing United States v. Ron Pair Enters., 489 U.S 235, 241 (1989)].
The Nessa court next addressed the requirement that the funds at issue be exempt from taxation and determined that an inherited IRA is tax exempt under IRC section 408(e). The Nessa court dismissed the argument that an inherited IRA is somehow distinguishable from other IRC section 408 tax exempt IRAs because it is uniquely subject to certain rules and limitations in other sections of the Internal Revenue Code, particularly as regards distributions:
It is irrelevant whether a traditional IRA and an inherited IRA have different rules regarding minimum required distributions. Section 408(e) of the Internal Revenue Code provides, in pertinent part, that " [a]ny individual retirement account is exempt from taxation."
Id. at 315 (citation omitted; emphasis in original).
Finally, the Nessa court found support for its decision in section 522(b)(4)(C), which provides that retirement funds directly transferred from a section 408(a) tax-exempt fund or account to another such account continue to qualify for exemption under section 522(d)(12). Section 522(b)(4)(C) states:
For the purposes of paragraph (3)(C) and subsection (d)(12), the following shall apply:
...
(C) A direct transfer of retirement funds from 1 fund or account that is exempt from taxation under section 401, 403, 408, 408A, 414, 457, or 501(a) of the Internal Revenue Code of 1986, under section 401(a)(31) of the Internal Revenue Code of 1986, or otherwise, shall not cease to qualify for exemption under paragraph (3)(C) or subsection (d)(12) by reason of such direct transfer.
The Nessa court concluded that section 522(b)(4)(C) directly supported its decision that inherited IRAs qualify for the section 522(d)(12) exemption. Nessa, 426 B.R. at 315.
2. In re Tabor, Subsequent to the decision in Nessa, the bankruptcy court for the Middle District of Pennsylvania determined that inherited IRAs also are exempt under section 522(b)(3)(C). See, Bierbach v. Tabor (In re Tabor), 2010 Bankr. LEXIS 2051 (Bankr. M.D. Pa. 2010). In Tabor, the debtor inherited an IRA pre-petition, appropriately created an inherited IRA, and took substantial distributions from the inherited IRA pre-petition. Id. at *3.
The Tabor court acknowledged that the Internal Revenue Code treats inherited IRAs differently than it does accounts funded by an individual's own employment earnings in certain respects. Id. at *8. It then noted that BAPCPA expanded the exemption status of IRAs to include any retirement funds held in an account exempt from taxation under specific Internal Revenue Code sections, without reference to whether such funds were necessary for the support of the debtor or the debtor's dependents. Id. at *12. And it further emphasized that as a result of section 522(b)(4)(C): "[t]his increased protection is afforded not only to an IRA account created by the debtor, but also extends to accounts that are transferred directly between trustees (e.g., inherited accounts) and to roll over distributions." Id. at *13. The Tabor court held that the language of section 522(b)(3)(C) unambiguously applies to inherited IRAs, although it also acknowledged that it was unclear whether Congress realized that inherited IRAs were "trustee to trustee" accounts. Id. Based on the above and expressly agreeing with the Nessa court's analysis, the Tabor court held that the funds in an inherited IRA are retirement funds, that an inherited IRA is tax exempt under IRC section 408, and that, as a result, an inherited IRA is exempt under section 522(b)(3)(C). Id. at* 17.
3. In re Chilton. While the Court finds the Nessa and Tabor analyses compelling, the Court recognizes that at least one well-written recent decision argues to the contrary. In In re Chilton, 426 B.R. 612 (Bankr. E.D. Tex. 2010), the court determined that an inherited IRA was not exempt under section 522(d)(12). Given the identity of language between section 522(d)(12) and section 522(b)(3)(C), the Chilton analysis could also control in this case. Chilton involved an inherited IRA, and its facts are not distinguishable from those of Nessa, Tabor, or the case here.
During the period of time the Court had this matter under submission, a decision was entered by the bankruptcy court for the Southern District of Indiana, which cited with approval to the reasoning in Chilton. See, In re Klipsch, 2010 Bankr. LEXIS 1845 (Bankr. S.D. Ind. 2010). The Klipsch decision focused solely on Indiana state exemption law, however, and for that reason is not further discussed herein.
The Chilton court's analysis differed from that of the Nessa and Tabor courts in three significant ways. First, the Chilton court determined that the term "retirement funds" must be interpreted so as to exclude inherited IRAs. It determined that: "[an argument that funds in an inherited IRA are retirement funds] collapses the question of whether an inherited IRA is a tax exempt account with whether an inherited IRA contains retirement funds." Chilton, 426 B.R. at 617. The Chilton court, thus, ultimately concluded that the plain language of the statute required the conclusion that funds in an inherited IRA are not retirement funds as they are not funds intended for retirement purposes but instead are distributed to the beneficiary of the account without regard to age or retirement status. Id. at 618.
Also, the Chilton court concluded that an inherited IRA is not a "traditional IRA exempt from taxation under [IRC section] 408(e)(1)." Id. at 622 (emphasis added). The Chilton court reached this conclusion notwithstanding the broad language of IRC section 408(e) which actually states that: "[a]ny individual retirement account is exempt from taxation under this subtitle unless such account has ceased to be an individual retirement account by reason of paragraph (2) or (3)." 26 U.S.C. § 408(e)(1) (emphasis added). The Chilton court then concluded that an inherited IRA is actually exempt under IRC section 402 (c)(11). Id. at 621. Section 402(c)(11) allows the trustee-to-trustee rollover necessary to create an inherited IRA and states that an inherited IRA: "shall be treated as an inherited individual retirement account or individual retirement annuity (within the meaning of section 408(d)(3).... for purposes of this title." 11 U.S.C. §402(c)(11)(A)(ii).
Paragraphs (2) and (3) pertain to factual scenarios not implicated here (prohibited transactions and borrowing on annuity contracts). See, 26 U.S.C. § 408(e)(2) & (3).
Finally, while the Chilton court discussed a myriad of other factors, it failed to discuss section 522(b)(4)(C). Thus, it failed to consider the impact of this portion of the statute on its conclusion that inherited IRAs are not subject to the section 522(d)(12) exemption.
D. The Court Adopts The Analysis In Nessa And Tabor And Reaches The Conclusion That The Debtor May Claim The Recipient IRA Exempt Under Section 522(b)(3)(C).
For this Court, the closest question when considering the applicability of section 522(b)(3)(C) to an inherited IRA is whether the funds in an inherited IRA are "retirement funds" within the meaning of section 522(b)(3)(C). Both sides of the debate assert that the "plain language" of the statute supports its view. Nessa, 426 B.R. at 314; Chilton, 426 B.R. at 617-18. And the Court is well aware that where the statutory language is clear: "the sole function of the courts is to enforce it according to its terms.'" United States v. Ron Pair Enters., 489 U.S. at 241 (citation omitted). Each side in the debate also points to a rule of statutory construction to bolster its reading of the statute.
The Chilton court argues that determining that funds in an inherited IRA are retirement funds inappropriately requires that the Court read the word "retirement" out of the statute. Chilton, 426 B.R. at 617. In essence, it argues that Congress could have exempted "funds" in any tax-exempt IRA, but did not. As a result, the court concludes, the word "retirement" must have meaning and asserts that such meaning is found only where the funds are necessary for a debtor's own retirement needs. Id. at 618, 620-21. The Chilton court correctly notes that the funds in an inherited IRA may not be required by a debtor for retirement or used to meet a debtor's retirement needs. The Court finds this analysis logical and would be inclined to adopt it, but for the fact that the Chilton court fails to consider and discuss the express language of section 522(b)(4)(C).
The Nessa and Tabor courts correctly recognize that the entirety of the statute must be considered. Nessa, 426 B.R. at 315; Tabor, 2010 Bankr. LEXIS at *16. The plain language of section 522(b)(4)(C) expressly provides that transfers of the type that create an inherited IRA do not cause a loss of exemption eligibility. The Court agrees with the Nessa and Tabor courts that this statutory provision makes it difficult to adopt the Chilton view.
Further, there is an answer to the Chilton court's concern. The funds in an inherited IRA are, in fact, retirement funds within the definitional constraints erected by that court, albeit that they are retirement funds of a non-debtor. Thus, as the Nessa and Tabor courts argue, one could conclude that it is the Chilton court that fails to enforce the statute's plain language as it reads the statute as meaning the "debtor's retirement funds." In so doing, it arguably adds a word to the statute that creates a limitation unintended by Congress and inconsistent with the statute's plain meaning.
Thus, the Court concludes that the funds in an inherited IRA are retirement funds within the meaning of section 522(b)(3)(C). To determine otherwise would require the Court to ignore that these funds were retirement funds within any reasonable view of the definition, albeit of the debtor's relative and not the debtor, to assume that Congress limited the term retirement funds in a manner not clear from the plain language, and to ignore the impact of another provision of the statute. While this is a close call, the Court ultimately finds the analysis in the Nessa and Tabor cases to be the more compelling.
The Court has less trouble with other portions of the Chilton analysis. The Court disagrees with the suggestion that an inherited IRA is exempt under IRC section 402(c)(11). That statute expressly states that certain transfers, rather than constituting taxable distributions, are treated as eligible rollover distributions, and the individual retirement plan treated as an inherited IRA under IRC section 408 and subject to IRC section 401(a)(9)(B). 26 U.S.C. § 402(c)(11)(A). And, contrary to the Chilton court's reading of IRC section 408(e)(1) as limited to "traditional" IRA's, the code section expressly states that "any" individual retirement account is exempt from taxation under IRC section 408. The Court finds nothing in IRC section 402 that independently provides for tax-exemption.
Unless the employee engages in a prohibited transaction or borrows from an annuity contract-neither of which circumstance is alleged here. See, 26 U.S.C. § 408(e)(2) & (3).
Finally, as the Nessa and Tabor courts note, the Chilton court failed to take into account the express statutory language that provides that a trustee-to-trustee rollover, such as the rollover that creates an inherited IRA, will not have an impact on the exempt status of an individual retirement account. This Court agrees that this point is significant and that this omission makes it impossible to follow the Chilton analysis.
Thus, the Court determines that an inherited IRA may be claimed as exempt under section 522(b)(3)(C). An inherited IRA contains retirement funds. It is exempt from taxation under IRC section 408. Thus, the statutory requirements are met.
Because the Court determines that the Recipient IRA is exempt under section 522(b)(3)(C), the Court does not need to determine whether the Recipient IRA also is exempt under Cal. Code Civ. Proc. 703.140(b)(10)(E).
In a pre-BAPCPA decision cited by the court in Chilton, a colleague carefully and appropriately analyzed the similar provisions of California law and concluded that the funds in an inherited IRA would not be exempt as they were not "retirement funds." See, In re Greenfield, 289 B.R. 146 (Bankr. S.D. Cal. 2003). In so doing, the court focused on the probable intent of the California legislature in using the term retirement funds. Id. at 150. The court concluded that the term "retirement funds" was best understood in that context as referring to retirement funds intended for the Debtor's retirement. Id. This Court does not disagree here. When evaluating the federal statute, as opposed to the California statute, a different conclusion regarding legislative intent is required given the inclusion in the Bankruptcy Code of section 522(b)(4)(C). As discussed above, this portion of the statute makes clear that retirement funds do not lose their exempt character as a result of a direct trustee-to-trustee transfer. Here, the funds in question were clearly "retirement funds" of the Debtor's mother. They came into the Debtor's hands only as a result of such a direct trustee-to-trustee transfer. Thus, this legislative language suggests that Congress had a legislative intent perhaps different from that of the California legislature. Thus, were this Court analyzing the statutory language of the California law, a different result might be appropriate.
CONCLUSION
The Court assumes the Debtor's claim of exemption to be modified to explicitly include section 522(b)(3)(C) as a basis for exemption of the Recipient IRA. The Court requires that the Debtor modify the schedules immediately to reflect this modification. Concurrent with this modification, the Trustee's objection to the debtor's claim of exemption of the Recipient IRA is overruled, and the Debtor may submit his order so providing.